Use of Annuities as a Medicaid Planning Tool in Colorado

The state regulations on treatment of annuities are found in Section 8.110.55 & 8.110.56, Volume 8 of the Colorado Department of Health Care Policy and Financing Medicaid Staff Manual, 10 C.C.R. 2505-10. In that section, an annuity is now defined as:

“. . . a contract between and individual and a commercial company, in which the individual invests funds

and in return is guaranteed fixed substantially equal installments for life or a specified number of years.”

Under Colorado Medicaid regulations, once an annuity has been annuitized and the annuitant is receiving regular distributions, the annuity is no longer considered as part of the asset pool for purposes of determining Medicaid eligibility. Instead, the monthly distributions are considered income to the annuitant in the month received.

Prior to the enactment of the current annuity regulations, which became effective on April 1, 1998, annuities could be used with relative safety in Medicaid estate planning in Colorado as a means of spending down countable assets and converting them into income for eligibility purposes. This method had been particularly useful in Medicaid planning for a married couple subject to the spousal impoverishment regulations.

The assets of both spouses are counted in determining the asset eligibility of the institutionalized spouse, while only the income of the institutionalized spouse is considered in determining income eligibility. By using assets of the married couple in excess of the CSRA to purchase an annuity which was then annuitized with payments going to the community spouse, the couple was able to spend down their assets without effecting the income eligibility of the institutionalized spouse. Meanwhile, the community spouse was allowed to continue enjoying the benefit of the former asset in the form of increased monthly income.

While the enactment of new regulations in 1998 placed some restrictions on the use of annuities purchased after April 1, 1998, it did not eliminate the use of annuities as an effective Medicaid planning tool for several reasons.

First, the 1998 regulations only affect annuities purchased after April 1, 1998. Annuities that were purchased prior to April 1, 1998 are still governed by the old regulations, whether or not they have already been annuitized. For an institutionalized spouse already on Medicaid, where the community spouse is receiving monthly payments from an annuity purchased and annuitized prior to April 1, 1998, the new regulations will not affect the institutionalized spouse’s continued eligibility for Medicaid benefits. Also, for an institutionalized spouse applying for Medicaid after April 1, 1998, an annuity purchased prior to that date can still be annuitized to reduce countable assets and the treatment of the resulting income to the community spouse will not be affected by the new regulations.

Second, even for couples who are only now planning for future Medicaid eligibility, the purchase of an annuity subject to the new regulations may still be a viable planning tool, depending on the circumstances.

The regulations governing treatment of annuities purchased prior to April 1, 1998 distinguish further between annuities purchased before or after July 1, 1995.

Any annuity purchased prior to July 1, 1995 by the applicant or the applicant’s spouse will be considered a countable resource to the Medicaid applicant only if it has not been annuitized. If the annuity is annuitized and the annuitant is receiving regular returns, the funds received will be considered income to the annuitant in the month received.

The only limitation imposed on annuities purchased before July 1, 1995 is that the annuity must meet the definition of “annuity”. That is, it must be: 1) a contract between and individual and a commercial company; 2) the annuity must provide a guaranteed income stream that is in fixed substantially equal installments (e.g., not a balloon or deferred lump sum annuity); and 3) the annuity period must be for life or a specified number of years.

For annuities purchase after July 1, 1995, the regulations provide four additional restrictions. If the annuity does not fit within all of the additional restrictions, the entire purchase price of the annuity is considered a transfer of assets without fair consideration and would trigger a period of ineligibility. In order to avoid the transfer penalty, the annuity must meet the following criteria, in addition to those applicable to annuities purchased prior to July 1, 1995:

1) The annuity must have been purchased from a life insurance company or other commercial company that sells annuities as part of its normal course of business;

2) The annuity must be annuitized for the applicant or the community spouse (although, for practical reasons, the community spouse would always be named as the annuitant);

3) The annuity must have been purchased on the life of the applicant or the community spouse; and

4) The annuity must provide payments for a period not to exceed the projected life of the annuitant (as determined by use of the appropriate life expectancy table -- male or female -- contained in the regulations).

The regulations are troublesome. The MMMNA is typically not determined until a Medicaid application is filed for the institutionalized spouse. Since the MMMNA can range from the base amount (currently $1,822) up to a maximum MMMNA (currently $2,739), depending upon the existence and amount of excess shelter costs to the community spouse, the new regulation creates some uncertainty for planning purposes. If an annuity is purchased today, how much can it pay out without the community spouse’s monthly income exceeding the MMMNA that will be calculated for him or her upon the filing of a future Medicaid application? Unless the state Department can somehow be required to determine the MMMNA during the Medicaid planning period, an exact answer to this question cannot be provided. This leaves people in the process of Medicaid planning, to be on the safe side, in the position of having to base their annuity purchase decision on the base MMMNA then in effect.

In the Medicaid planning context, it is necessary, as a practical matter, to assume a conservative application of the terms of the regulations. That is, projections of possible transfer penalties which may be triggered by annuity income must be based upon a presumption of the application of the minimum current MMMNA amount. This means that the projected benefit from purchase of an annuity will usually need to be measured against the fact that annuity payments up to the amount of the MMMNA will essentially represent a replacement of the MIA. Usually, this will still weigh in favor of an annuity purchase, since the source from which MIA will be paid, (e.g. institutionalized spouse’s pension), may not survive the death of the institutionalized spouse. An annuity will continue to pay out to the community spouse for the remainder of the annuity period, avoiding impoverishment of the community spouse upon the death of the institutionalized spouse. In addition, upon the death of the community spouse, the community spouse’s children can be designated to receive the balance of any annuity payments remaining after repayment to Colorado for Medicaid benefits provided to the institutionalized spouse. Thus, there are some advantages over merely relying on the MIA.

Often, even the maximum MMMNA will not be sufficient for the community spouse to pay his or her monthly obligations and living expenses; or will not allow the community spouse to continue living the lifestyle to which he or she has become accustomed. In these cases, it may be worth incurring a transfer penalty to purchase an annuity that will provide a sufficient supplement to the community spouse's income to meet his or her ongoing needs.

As a practical matter, any purchase of an annuity for Medicaid planning purposes will usually involve an expenditure of assets in excess of the CSRA. As a result, there will usually be the potential for the imposition of a transfer penalty, depending on the effects on the community spouse’s income upon annuitization. Therefore, an essential part of the decision to purchase an annuity will now be the computation of the expected penalty period.

The regulation does not set forth the mathematical formula for calculating the penalty period, but it does provide that the transfer will consist of that portion of the monthly income in excess of the MMMNA which is caused by the purchase of the annuity from funds in excess of the CSRA. Knowing this, the formula for calculating the penalty period when the annuity payment causes total income to exceed the MMMNA, which can be deduced algebraically, is as follows:

( [(TI - MMMNA) - NAI] ÷ AI) x EA = PP

ACNC

Where: TI = Total monthly income to community spouse, including annuity payment

MMMNA = Minimum monthly maintenance needs allowance

NAI = Total monthly income in excess of MMMNA from sources other than the monthly annuity income

AI = Total monthly income from the annuity

EA = Excess assets above the CSRA used to purchase the annuity

ACNC = The average cost of one month of nursing home care in Colorado

PP = The penalty period in months

For example: Assume that a couple has $140,760.00 in non-exempt assets. The community spouse’s total monthly income is her social security benefit of $800.00. Institutionalized spouse’s monthly income is less than $2,022.00, so that he is income qualified for Medicaid benefits. The couple needs to spend down $31,200.00 in order to reduce their total non-exempt assets to the CSRA of $109,560.00. If they purchase an annuity, the annuity payment over the annuity period (based upon the remaining life expectancy of the institutionalized spouse) will be $1,500.00 per month. The community spouse’s total income from social security and the annuity payment will be $2,300.00. The current MMMNA is 1,822 and the current (2010) average cost of one month of nursing home care in Colorado is $6,267. The projected penalty period will be calculated as follows:

([(2,300 - 1,822) - 0] ÷ 1,500) x 31,200 = 1.659

6,267

$2,300 - $1,822 = $478

$478 - 0 = $478

$478 ÷ $1,500 = .319

.319 x $31,200 = $9,952.80 (The amount transferred for less than fair consideration)

$9,952.80 ÷ $6,267 = 1.588 or 1 month and 18 days of ineligibility

As you can see from the above example, the penalty period would be significantly less than that which would be imposed on an outright transfer of $31,200. ( $31,200 ÷ $6,267 = 4.98 or 5 months of ineligibiilty). The more that annuity income would raise the community spouse’s monthly income over the MMMNA, the longer the transfer penalty will be; and the closer the period of ineligibility would be to that resulting from an outright gift transfer (e.g. to the couple’s children) of the amount used to purchase the annuity. Therefore, the use of annuities would make the most sense in situations where the community spouse has a small monthly income.

Note: the above formula only applies in cases where the annuity payment will cause the community spouse's monthly income to exceed the MMMNA. If the annuity purchased does not cause the community spouse’s monthly income to exceed the MMMNA, there will be no transfer for less than fair consideration. Also, if the annuity is purchased at a time when the couple’s assets do not exceed the CSRA, no penalty period will be imposed, regardless of the monthly income resulting. Finally, if a Medicaid application is not filed until 36 months after the purchase of the annuity (60 months if the annuity was purchased on or after February 8, 2006), there will be no transfer penalty, regardless of the amount of excess assets used to purchase the annuity or the amount of income paid out each month by the annuity.

To see our "2010 WORKSHEET FOR CALCULATING PENALTY PERIOD FOR COMMUNITY SPOUSE ANNUITIES PURCHASED ON OR AFTER APRIL 1, 1998", CLICK HERE.

Treatment of Annuities Payable to the Medicaid Recipient and Purchased on or after February 8, 2006

As stated earlier, the above rule only applies where the annuitant is the Medicaid recipient's community spouse. Purchasing an annuity which will make monthly payments to the Medicaid recipient will not result in a transfer penalty, regardless of the size of the annuity payment, so long as the annuity meets the following criteria contained in the DRA:[i]

1. The annuity must have been purchased from a life insurance company or other commercial company that sells annuities as part of its normal course of business; and

2. The annuity must be annuitized to the Medicaid recipient; and

a. The annuity must be "actuarially sound," meaning it must be designed to pay out completely during the Medicaid recipient's remaining life expectancy (as determined by the appropriate life expectancy table -- male or female -- contained in the regulations); and

b. The annuity must make substantially equal payments over the entire period of the annuity; OR

c. The annuity is a qualified individual retirement annuity under IRC '408(b) or (q), or the annuity is purchased from a qualified individual retirement plan under IRC '408(a), (c), (p) or (k) or IRC '408A; and

5. The annuity must name the state as death beneficiary, at least up the amount of Medicaid benefits paid to annuitant. The state must be named as first death beneficiary unless the recipient has a spouse or a minor or disabled child, in which case that spouse or child may be named as first death beneficiary, with the state as second beneficiary if the spouse or child disposes of his or her remainder interest without fair consideration.

At first glance, it would seem futile to purchase such an annuity, since virtually all of the annuity payments after the Medicaid recipient enters the nursing home (or begins receiving long term care services at home) will be used to pay for long term care expenses. However, such an annuity could be a very effective planning tool whenever the Medicaid recipient makes gift transfers on or after February 8, 2006 to qualify for Medicaid.

The annuity would be purchased with all of the Medicaid recipient's excess resources remaining after completion of the recipient's "spend down" and other gift transfers (i.e., the hold-back amount in a "half loaf" gifting plan); and would be structured to pay out for a term not to exceed the penalty period from the transfers, or 60 months, whichever is shorter. Further, the monthly payments from the annuity would be designed to pay for the recipient's monthly long term care expenses in excess of the recipient's other income during the penalty period or look-back period. Finally, the annuity should not be annuitized until the recipient enters the nursing home or begins receiving long term care services at home.

Once annuitized, the annuity would no longer be countable as a resource and would not, by itself, delay the start of the penalty period once the Medicaid recipient is in a long term care setting and receiving services, since the recipient would have no more excess resources and would qualify for Medicaid, but for the transfers. The annuity payments could then provide for the Medicaid recipient's nursing home or other long term care expenses during the penalty period or look-back period. Once the annuity is exhausted and the penalty period or look-back period has expired, the recipient could begin receiving Medicaid long term care benefits in the nursing home or at home through HCBS.

Unfortunately, it can still be difficult to find commercial annuities fitting these requirements and which are available for a period certain of less than 18 months. Perhaps this will change if there is a great enough demand for a Medicaid-friendly annuity product of shorter duration. However, until a shorter term annuity product may become available, the use of an annuity to "bridge" the penalty period from gift transfers may not make sense unless the penalty period is approximately 18 months or more. Otherwise, a different strategy, such as a trust, reverse mortgage or long term care insurance, may be used.

[i] S. 1932, §6012(b) & (c).